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NuStar Energy LP (NYSE:NS)

Q1 2009 Earnings Call

April 30, 2009 3:30 pm ET

Executives

Mark Meador – Vice President, Investor Relations

Curt Anastasio – President & Chief Executive Officer

Steven Blank – Senior Vice President, Chief Financial Officer & Treasurer

Mike Stone – Vice President, Asphalt Marketing

Danny Oliver – Vice President, Marketing & Business Development

Mike Hoeltzel – Senior Vice President, Strategic Planning

Analysts

Brian Zarahn – Barclays Capital

Christopher Taylor – Evergreen Investments

Ross Payne – Wachovia

Louis Shamie – Zimmer Lucas

Andrew Gundlach – ASB

Michael Blum – Wachovia

Darren Horowitz – Raymond James

Yves Siegel – Aroya Capital

Operator

Good afternoon. My name is Kate and I will be your conference operator today. At this time I would like to welcome everyone to the NuStar Energy LP and NuStar GP Holdings, LLC first quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. Mark Meador, you may begin your conference.

Mark Meador

Thank you, operator. Good afternoon. Welcome to our conference call to discuss NuStar Energy LP and NuStar GP Holdings, LLC’s first quarter 2009 earnings results. If you have not received the earnings releases and would like copies of each, you may obtain them from our websites at nustarenergy.com and nustargp.com. Attached to the earnings releases, we have provided additional financial information for both companies, including information on NuStar Energy LP’s business segments. In addition, we have posted operating highlights and fundamental data for our asphalt operations under the investors portion of the NuStar Energy LP website. If after reviewing the attached tables and operating highlights, you have questions on the information that is presented there, please feel free to contact us after the call.

With me today is Curt Anastasio, CEO and President of NuStar Energy LP and NuStar GP Holdings, LLC; Steve Blank, our CFO and other members of our management team.

Before we get started, we would like to remind you that during the course of this call, NuStar Management will make certain statements concerning the future performance of NuStar and other statements that will be forward-looking statements, as defined by securities laws. These statements reflect our current views with regard to future events and are subject to various risks, uncertainties, and assumptions. Actual results may materially differ from those discussed in these forward-looking statements, and you should refer to the additional information contained in NuStar Energy and NuStar GP Holdings, Form 10-Ks for the year ended December 31, 2008, and any subsequent filings with the Securities and Exchange Commission.

During the course of this call, we will also make reference to certain non-GAAP financial measures. We’ve provided additional schedules, under the investors and financial reports and SEC filings portion of the NuStar Energy LP website, reconciling these certain non-GAAP financial measures to the most directly comparable financial measure, calculated and presented in accordance with U.S. Generally Accepted Accounting Principles, or GAAP. Our non-GAAP financial measures should not be considered as alternatives to GAAP measures; such as net income, operating income, net cash flows provided by operating activities, or any other GAAP measures of liquidity or financial performance.

I’ll now turn the call over to Curt.

Curt Anastasio

Good afternoon and thanks for joining us. I'm excited to say that NuStar Energy LP reported better than expected earnings of $0.58 per unit for the first quarter of 2009, compared to the guidance of $0.25 to $0.50 per unit we communicated previously. In addition, NuStar GP Holdings also reported better than expected earnings of $0.28 per unit for the first quarter of '09. Not only did our first quarter 2009 earnings for both NuStar Energy and NuStar GP Holdings surpass our expectations they also exceeded analyst estimates. This was especially noteworthy since the first quarter presented challenging business conditions including economic weakness, poor weather, turnarounds at several refineries we serve and the typical seasonality of our asphalt operation.

I would like to point out that a straight-up comparison of our first quarter results to last year's first quarter is almost meaningless as we acquired the former CITGO asphalt refining and marketing operations near the end of the first quarter of 2008. Had we not had the asphalt operations, our results in the first quarter of 2009 would have been slightly higher, compared to last year's first quarter results, excluding certain one-time items.

However, due to the seasonality of asphalt, our first quarter 2009 results are burdened with all of the additional costs and expense of that operation, while the vast majority of the financial benefit will be generated during the second and third quarter. The important take-away for our unitholders is that the financial results of our transportation and storage terminal segment, during the first quarter of 2009 were actually better than the first quarter of 2008. And for the full year 2009, the asphalt business and our other two segments are expected to provide an even bigger boost to earnings to cash flow than they did in 2008.

The LPs distributable cash flow applicable to limited partners was also better than expected coming in around $69.4 million or a $1.28 per unit for the first quarter of ’09 and was the third best quarterly distributable cash flow performance since the LP went public in 2001. In addition, the LP Board declared a $1.0575 per unit distribution payable May 15 and the GP Board declared a $0.43 per unit distribution payable May 20. Both are increases over the first quarter payments of last year, with the LP distribution representing a 7.4% increase and the GP distribution representing a 19.4% increase. These distributions remain unchanged from the fourth quarter 2008 distribution. I am also pleased to say that the LP continues to have a solid distribution coverage ratio, despite a softer earnings quarter, compared to the first quarter of last year.

Distributable cash flow covered the distribution by a factor of 1.21 times to the limited partners for the first quarter of 2009. On another positive note, I'm happy to say that NuStar is now a Fortune 500 Company. Last week, we learned that NuStar ranked number 485 on the 2008 list, based on our record revenues of $4.8 billion last year. Again this accomplishment is indicative of the significant scale that NuStar has achieved in record time through its successful growth strategy.

This tops outs a year in which we had a number of other achievements, which include earning a rank on Fortune Magazine's prestigious listing of the 100 Best Companies to Work For in America awarded the Number 1 Best Large Company to Work For in the State of Texas by Texas Monthly. And we were named the Top Workplace in San Antonio by the San Antonio Business Journal. And because the company puts safety first, NuStar Energy had the best safety and environmental performance in the industry and in its eight-year history. The total recordable injury rate and the lost time injury rate, two important measures of safety performance were far better than the industry averages and the reason that the company continues to win National Safety Awards.

Last year, we won several honors from the National Safety Council and the Independent Liquid Terminals Association. And in the first quarter of this year for the first time in NuStar's history, we had no recordable or lost time injuries. We were also recently awarded, CSX Transportation's Chemical Safety Excellence award for our track record safely handling railcars. All of these great accomplishments have set the stage for 2009 to be another record year. Now I would like to review some of the reasons why all three of our business segments performed better than we expected in the first quarter.

Our transportation and storage segments continue to perform well with higher profits, despite lower volumes on pipelines and throughput related facilities. Both segments generated higher operating income results, compared to expectations and compared to the first quarter results from last year. What's impressive is that the first quarter 2009's operating income of $36.5 million from our transportation segment was better than any quarter in 2008 except for the fourth, which came in just slightly higher at $39.1 million. What's even more impressive is that these two quarters also had the lowest throughput volumes for that respective period.

So, bottom line is we generated better results on lower throughput volumes. Part of this is attributable to the tariff increases, we implemented July 1, 2008. We also benefited from lower operating expenses in the first quarter of 2009, resulting from a decline in power and maintenance and repair costs. Reduced energy prices or more specifically, lower natural gas prices have had a positive impact on our costs therefore boosting the bottom line. So, lower throughput in a period of lower oil prices also lowers NuStar's cost. The same thing can be said for our storage segment, which generated the highest all-time quarterly operating income in the first quarter of 2009 or $46.7 million despite lower throughput.

Lower throughputs don't necessarily translate into weaker earnings in this segment because the majority of our business is contracted. The completion of expansion projects under our $400 million construction program, renewals of lease contracts at higher rates due to strong demand for storage at key terminals, and the conversion of some of our throughput based contracts to lease-based contracts allowed us to generate higher earnings compared to last year.

Taking a more detailed look at the throughputs of our transportation and storage segments in the first quarter. Transportation volumes declined around 9% quarter-over-quarter. Approximately, 5% of the decline was related to the impact of planned refinery turnarounds and lower refinery runs. 1% was from the sale of our joint venture interest in the Skelly Belvieu pipeline in Texas in the fourth quarter of 2008. And 2% from lower volumes on our El Paso pipeline space as a shipper acquired our JV partners interest in the middle of the first quarter of '08 and continues to ship on its purchased space.

Storage segment throughputs declined around 25% versus the first quarter of 2008, but the large majority of the decline or about 16% related to the impact of planned refinery turnarounds. In addition, 7% was due to the conversion of throughput-based contracts to lease-based contracts that has actually allowed us to capture a higher margin and make more money. The final 2% was from lower refinery runs due to the economic downturn. So, the economic downturn has not had as big an impact to our fee based business, as you might have expected. And we continue to target better earnings in both the transportation and storage segments for 2009 despite lower volume.

Results from the asphalt and fuels marketing segment were also above expectations, mainly due to our asphalt operations, as we benefited from higher asphalt margins and sales volumes versus what we anticipated. Within our asphalt and fuels marketing segments, our asphalt operations generated a $1.7 million adjusted EBITDA loss and our fuels marketing operations generated adjusted EBITDA of a positive $2.1 million. Our asphalt sales volumes, while on plan were seasonally low in the first quarter of 2009 as expected.

While our margin was good at nearly $6 a barrel, sales did not generate enough gross margin to cover our operating costs resulting in slightly negative EBITDA. Again this is very typical for this time of year as colder weather prevents us from laying paving grade asphalt. Asphalt sales volumes are increasing as we speak as the weather improves in the U.S. Northeast. In our fuels marketing operations, while we generated positive earnings, our bunkering operation came in less than anticipated as average sales prices for our bunkering inventory at Point Tupper, Nova Scotia were less than its costs. As you might recall, we entered the bunkering business at Point Tupper last summer, when prices were around their all time high.

Since, we hedged this inventory and prices subsequently collapsed, we generated a hedge gain in the fourth quarter of 2008, which offset the loss on the physical sales. Looking at some of our expenses for the first quarter, G&A expenses were higher by $6.4 million, compared to the first quarter of 2008 mainly due to the impact of an increase in the unit price in the first quarter of 2009 and the impact that that has on our unit options expense, versus a decrease in price in the first quarter of 2008.

To a lesser degree, hiring additional employees associated with the former CITGO asphalt refining and marketing business as well as to support the company's other businesses also resulted in higher G&A. Depreciation and amortization was $5.9 million higher than the first quarter of last year. Mainly due to the CITGO acquisition and the completion of our growth projects. Interest expense was higher, compared to the first quarter of '08, primarily due to the 10-year bonds we issued early last year that were used to partly finance the CITGO acquisition and the associated working capital as well as growth projects.

On a positive note, interest expense declined from the fourth quarter of 2008 due to lower interest rates. Currently, the rate on our revolver based on LIBOR plus 50 basis points, is around 1%, a very low rate. We expect rates will continue to be low throughout 2009 and because we expect to pay down additional debt this year, interest expense should be lower in 2009, compared to 2008. And last, income tax expense was higher than last year and higher than guidance, mainly due to additional tax incurred on the gain on insurance proceeds we received for the impact of Hurricane Ike at our Texas City Terminal.

Looking ahead to the remainder of 2009, the outlook for NuStar has never been better, despite an anticipated weak economy this year, we expect 2009 to be another record year for NuStar due to higher results from all three of our business segments. And we continue to target further distribution increases this year for both NuStar Energy and NuStar GP Holdings. A tariff increase projected to be around 7.5% effective July 1, '09 should result in higher earnings in our transportation segment.

New pipeline business, the addition of a new pipeline in Kansas exposure to market areas that are agriculturally oriented and reduced refinery maintenance this year, should all help mitigate the impact of lower throughput volumes resulting from lower demand. Our storage segment is also expected to do well this year, as the completion of projects under our $400 million construction program and contract renewals at higher rates due to the strong demand for storage at certain of our key terminal facilities should also provide a nice bump in earnings in 2009.

We continue to project incremental EBITDA of over $30 million in 2009 in the storage segment and we're really excited about the potential for our asphalt operations this year, as we expect the fundamentals to be even more favorable. While the asphalt season got off to a slow start due to poor weather, sales volumes have started picking up as weather on the U.S. East Coast improves. We believe asphalt supply will be even tighter this year than it was in 2008 mainly due to a combination of low U.S. refinery utilization rates, which will limit asphalt production and higher demand from stimulus spending from the government.

Asphalt supply started off the year at low levels, as United States asphalt inventories were below their five-year averages. U.S. refinery utilization rates continue to be at historic lows, due to the weak economy and the resulting lower refining margins. If you look back at the last 20 years or so, U.S. refinery utilization rates have been around, between the mid-80% to the mid-90% range. In the last eight months, however, rates have been as low as 75 to low 80% range and we expect that to continue near term.

In fact, the United States Energy Information Administration is forecasting that utilization rates will stay in the low 80% range for the year 2009. We also expect the lack of asphalt imports to continue and in the near term lower availability of heavy sour crudes should result in less bottoms being produced including asphalt. With regard to asphalt demand, a combination of lower crude oil and asphalt prices as well as the impact from stimulus funding should result in slightly higher asphalt demand in 2009. The recently passed stimulus plan otherwise called the American Recovery and Revitalization Act provides around $29 billion for transportation and infrastructure projects. With the vast majority of the spending about 85% expected to go toward asphalt projects.

The timing of the stimulus funds appears to be on track with what was laid out in the legislation and we expect to start seeing the impact of stimulus funds on our demand in the third quarter of this year. Recall that the law requires that half of the funds must be obligated within a 120 days of being apportioned. Otherwise, those funds will be sent back to the Federal government for redistribution. Right now, we're on day 59 and so far, nearly $8 billion has been obligated.

Eight states have already granted contracts and started making payments to contractors. While some states are being slowed down by their legislative budgetary process because of some of the social programs within the stimulus package, we do expect the highway-funding portion of the stimulus package to continue to stay on track within the set time lines. So, for 2009, we're expecting a higher margin per barrel and slightly higher sales volumes, assuming the impact from the stimulus package kicks in by late 2009 as described. Those assumptions would suggest that the EBITDA guidance range we communicated previously of $100 million to $140 million for the full year for asphalt in 2009, may be conservative. I would also like to say that we are currently receiving our full contract volumes of Venezuelan crude oil and have received no indication of further cuts.

Longer term, we remain just as bullish on the asphalt business as a combination of low U.S. refinery utilization rates, an improving economy, lack of asphalt imports, and coker projects coming online should result in a further tightening of the asphalt market and better than historic margins over the next several years. With respect to our results for the second quarter of 2009, we expect earnings per unit to be in the range of $0.80 per unit to $1.20 per unit, which would be a record for the second quarter. The majority of the projected increase in earnings for the second quarter is expected to come from much stronger asphalt results, as we get further into the paving season.

Looking at some expense estimates for the second quarter. Operating expenses are expected to be in the range of $125 million to $130 million. G&A expense in the range of $22 million to $23 million. Depreciation and amortization expense around $37 million to $38 million. Interest expense 20 to 21 million. And income tax expense in the range of $5 million to $6 million. Our guidance for capital expenditures has not changed as we continue to target $65 million to $70 million for reliability capital and around $80 million for internal growth projects for the full year of 2009.

In the first quarter, we spent nearly $6 million for reliability and around $21 million for the internal growth projects. The majority of that related to our storage business. The $80 million of growth projects continues to be made up of a mix of pipeline, storage expansion, terminal improvements, and asphalt refinery projects, including crude flexibility, energy efficiency, and polymer modified asphalt production enhancements. The average annual operating income contribution from the $80 million of growth projects is expected to be in the range of $25 million to $30 million and the weighted average internal rate of return for these projects is expected to be between 40% and 50%.

I’d like to reiterate that there is no shortage of growth opportunities for NuStar we continue to evaluate both attractive acquisition opportunities and internal growth projects in all three of our business segments. Our balance sheet continues to be in great shape. We have ample liquidity currently around $470 million on our revolver, and are well situated to execute our internal growth plans and to fund current operations and distribution payments without the need to access the capital markets. Keep in mind we have no significant debt maturities until the end of 2012 and into 2013 at which time our revolver and most of our senior notes will mature. And as I've mentioned, we plan to pay down additional debt throughout the year.

In summary, I'm certainly excited about this year and the future of our company. There are not many out there right now that can say they are targeting record earnings and dividend increases, and can internally fund all of their commitments while also paying down debt. This speaks to the quality of our strategy, our assets, our employees, and the management team. So at this time, I will open it up for Q&A. Operator?

Question–and–Answer Session

Operator

(Operator Instructions). And your first question is from Brian Zarahn from Barclays Capital.

Brian Zarahn – Barclays Capital

Good afternoon.

Curt Anastasio

Good afternoon.

Brian Zarahn – Barclays Capital

In your transportation segment, any changes to your views on volumes given the trends the past few quarters?

Curt Anastasio

No, I don't think so. I think we had guided to a slight reduction in volumes this year, but higher revenues and higher profits, so no change.

Brian Zarahn – Barclays Capital

Okay. I’m looking at asphalt, you mentioned you expect a lot of the money to be spent this year, but how should we think about the risk that the stimulus spending will miss the paving season this year and really won't have an impact for 2010?

Curt Anastasio

Whether you will see a lot, you will see most of the impact actually after '09, to 2010 and 2011, but we get increasing confidence as time has gone on here – we started out being very conservative about this late '08, when people asked us about it and we were saying look it's a political process and we're going to wait till it plays out. Well, it's been playing out. In March, the Fed released the funds, the states are now committing the projects. So, we have much greater visibility to say that we'll see the beginnings of an impact in, July or August of this year for us in terms of asphalt demand on us. The effect for this year really is a convert on the demand side, what we think would have been a slight decrease in demand year-over-year to a slight increase in demand year-over-year, but there's even a bigger impact in 2010. And there is some impact in 2011 as well, as the projects get funded from the stimulus money.

Brian Zarahn – Barclays Capital

And can you provide the cash balance for the end of the first quarter?

Mark Meador

It's about $12 million at NS and a few million dollars at NSH.

Brian Zarahn – Barclays Capital

Thank you.

Mark Meador

We paid off some debt by sweeping some cash from overseas.

Brian Zarahn – Barclays Capital

Thank you.

Curt Anastasio

You're welcome.

Operator

Your next question is from Chris Taylor from Evergreen Investments.

Christopher Taylor – Evergreen Investments

Thanks. Couple of questions, but first of all, the cash flow statement and the balance sheet statement were missing from your press release?

Curt Anastasio

They always are.

Christopher Taylor – Evergreen Investments

Can I recommend that now that you're in the marketing business, that you include those because obviously in the marketing business, that's more important than an income statement?

Curt Anastasio

We'll take it under advisement.

Christopher Taylor – Evergreen Investments

That would be a strong recommendation I would not be comfortable with an investment, and but…

Curt Anastasio

Friday. The next Friday…

Mark Meador

The Q will be filed, so in a week from tomorrow, you'll have all that information.

Christopher Taylor – Evergreen Investments

Well what type of hedging do you engage in for the marketing business?

Mark Meador

For the asphalt marketing business, none.

Christopher Taylor – Evergreen Investments

Okay.

Mark Meador

For the fuels marketing business, we do have inventory and we keep a completely hedged book on that side of the business.

Christopher Taylor – Evergreen Investments

Okay. And what is the net present value of your derivative position right now?

Mark Meador

All right.

Curt Anastasio

We will get that for you.

Mark Meador

We will get that for you.

Curt Anastasio

We will get back to you.

Christopher Taylor – Evergreen Investments

And then the second question about asphalt, do you have any benefit or have you seen any benefit from the SemGroup issues, it sounds like they’ve pretty much missed the 2009 marketing season. Have you been able to pick up any business as a result?

Mark Meador

We think it’s been helpful to us in the sense that, it’s restricted the available supply even further. They have been kind of out of the market and Mike Stone’s here, who runs our asphalt, they have been out of the market, they haven’t had the normal amount of inventory available for sale, so it’s helped, tight supply got even tighter I would say.

Mike Stone

It's helped us in, a little bit on the PMA business, which was the specialty products that they provided to the marketplace, but I think you're going to see the real impact later on this summer, because they were a big winter field player in past years and without asking the overall inventory levels in the whole system will be lower going into the season this year.

Christopher Taylor – Evergreen Investments

Did you look at the bidding that was going on for that, or is that something you might have an interest in?

Curt Anastasio

We're under a confidentiality agreement about that, but essentially what we have said publicly before I can say now is that, we were not a bidder for the entire business. It's apparent now actually there were no bidders for the entire business, that's the way its played out. But we had expressed interest in particular assets in particular terminals, either for purchase or lease. And so that's where we've left it and that continues to be our position with respect to the Sem asphalt business.

Christopher Taylor – Evergreen Investments

Thank you very much.

Operator

Your next question is from Ross Payne from Wachovia.

Ross Payne – Wachovia

How are you doing guys?

Curt Anastasio

Hi.

Ross Payne – Wachovia

First question, on the contango positions that you guys had this year, how much of your storage are you allowed, I mean are you currently using for your own account to do contango trades?

Curt Anastasio

Right now in about 600,000 barrels and we're trying to take that up close to a million as we speak.

Mark Meador

On a 90 million base of storage capacity.

Curt Anastasio

Right.

Ross Payne – Wachovia

Okay. All right. So, it’s really leased out significantly there. What are you seeing with rate, are you seeing any changes in rates for storage as we kind of come off some of the peak contango we've had recently or is it still strong?

Curt Anastasio

No, it's still strong. We're getting, well Danny Oliver is here, he does all our third-party storage business.

Danny Oliver

Yeah. In the first quarter, we were seeing significantly higher renewals, I would say it's north of the 20% on the renewals we saw in the first quarter. I would anticipate that they are still carrying the market and there is still a lot of interest in storage. So, I would anticipate seeing that throughout at least in the second quarter.

Ross Payne – Wachovia

Okay. So, you were resigning contracts 20% above the other ones in the first quarter?

Danny Oliver

Correct.

Ross Payne – Wachovia

Okay, okay. And finally, what are you hearing on the asphalt side just in terms of state municipalities, a lot of them have budget constraints that kind of thing. Just absent the stimulus bill, what kind of environment is it like out there dealing with the municipalities?

Mike Stone

States are in different positions. I think that our opinion is it's difficult for state to turn away any of the federal money. So, the Highway Trust Fund has been approved for this year of about $41 billion that we expect the state matching of roughly 20% to hold true again this industry.

Ross Payne – Wachovia

Okay. So, they only put up 20% of the federal funds that come through? Or what's the matching? Is it a 50:50 match or what was? Can you hear me?

Curt Anastasio

Yeah. I was trying to follow the question.

Ross Payne – Wachovia

Oh, okay. On the state match of the federal funds, how does that work again?

Mike Stone

It's about 20% of the total federal dollars, state matches 20%.

Ross Payne – Wachovia

Okay, okay. So, like you said that's hard to resist.

Curt Anastasio

They have a compulsion, the lower prices does help too. I mean last year, prices got really, really high. There is only one so, pot of money, right? So, the lower prices do help.

Mike Stone

The real negative impact this year could be from the private sector, which is the overall economy is down.

Ross Payne – Wachovia

All right.

Mike Stone

Private sector is where you are going to see a negative impact.

Curt Anastasio

That's one of the reasons we were forecasting a further decrease in demand this year, but that, the tighter, much tighter supply would result in higher margins anyway. That was before the effect of the stimulus. Now, with the stimulus, the demand outlook looks better.

Ross Payne – Wachovia

Right. What's the actual dollars change in asphalt look like year-over-year out of curiosity or what are your expectations for kind of midseason?

Curt Anastasio

Yeah, it…

Unidentified Company Representative

In terms of price we are spending. Talking about rack…

Curt Anastasio

Rack price.

Ross Payne – Wachovia

That would be fine.

Curt Anastasio

Okay. Last year was so unusual.

Danny Oliver

The average of last year was like 550 to $560 a ton, where right now 350 to something like that. So, it's materially less. So, the dollars will go a lot further on liquid. Is that?

Ross Payne – Wachovia

Okay.

Danny Oliver

You are asking?

Ross Payne – Wachovia

Yes it is. And I got a question on the private side. If people are looking at, they got a commercial property and granted that's a tough market right now, but if they're looking at having to repave a parking a lot, in the next two or three years, do you expect anybody to start accelerating those schedules to take advantage of the low commodity price we’re in or not?

Mike Stone

I don't think they would do that just because of the pricing I think the overall, I guess the overall condition of the economy in that position…

Ross Payne – Wachovia

Okay, okay. Great. Thanks guys. That's it for me.

Curt Anastasio

Okay.

Unidentified Company Representative

Okay.

Operator

Your next question is from Louis Shamie from Zimmer Lucas.

Louis Shamie – Zimmer Lucas

Hi, great quarter everybody.

Curt Anastasio

Thank you.

Louis Shamie – Zimmer Lucas

My question is regarding the guidance on the 80 million of CapEx generating a $25 million to $30 million, I guess in operating income return. How is that expected to split out between projects, what kind of impact will we see on 2009 and how much will be kind of incremental to 2010?

Curt Anastasio

I expect that…

Mike Stone

Well, the 80 million is part of course the projects that we’re working on this year, as several of them started last year and some of them will continue to 2010. So, the 80 million represents a portion of about 155 million total capital on strategic projects.

Curt Anastasio

Because we got some carryover capital.

Louis Shamie – Zimmer Lucas

Sure.

Curt Anastasio

Go ahead, Mike.

Mike Stone

In the operating income we're looking at total from those projects would be about 55 million of which we should be seeing 21 million this year and about another 20 million in 2010.

Louis Shamie – Zimmer Lucas

Okay, great. Thanks a lot guys.

Operator

Your next question is from Andrew Gundlach from ASB.

Curt Anastasio

Hi, Andrew.

Andrew Gundlach – ASB

Hi. Congratulations on a very, very good quarter. A similar follow-up to an earlier question. Could you give the inventory figure for the end of the quarter?

Curt Anastasio

The volume…

Andrew Gundlach – ASB

In total, combined would be great if you can break it out between finished goods and refinery seats that would be great too?

Curt Anastasio

Yeah. Hold on a second, we will just make sure we give you the exact right numbers. Just turning the page here.

Unidentified Company Representative

The inventories in total were 338 and I'm not sure if we've got it broken down here yet.

Curt Anastasio

But we do, we can get that.

Andrew Gundlach – ASB

That's fine. We can follow-up. And you mentioned just on an earlier question that the rack price was around $350, $370 that's what obviously what New Jersey says as well. I'm just curious how much business is being done – certainly when you drive around here locally, which is an area for you, you only see a lot of work crews out and stuff like that. I'm sure they are all coming to slow down the summer traffic, but can you give us a sense of how much business is actually being done, if there's a delay and maybe quantify a little bit more about how you talked about the season starting to pick up as we speak?

Curt Anastasio

Yeah. And we did have as you know, a lot of weather delay the start off especially in the Northern markets in the Northeast where you are, but it really has been taken up now, sales volumes have. Mike do you want to comment a little more on that?

Mike Stone

We are actually about 95% to a 100% of our sales plan or sales target year-to-date this year. And then we just recently in the last two weeks with the weather breaking in the Northeast have seen a significant increase in activity, so it looks good so far.

Danny Oliver

Andrew, on the inventory of that roughly 330-plus million figure, crude was only about 75 million and the rest was asphalt and finished products.

Andrew Gundlach – ASB

Okay. And then just one other thing on the margin thinking forward, is it your expectation that the, let's just go back to the original guidance and not the indications that you said, the original guidance of $100 million to $140 million. Is it still your expectation that you would make that money on asphalt alone? In other words, 70% of the barrels you're producing, and the non-asphalt would be a break-even business this year on a gross margin basis? In other words, should we bother to spend time watching 30% of the business or just assume that it's break-even and everything is going to come from asphalt?

Curt Anastasio

That margin we put out is for everything right, but….

Andrew Gundlach – ASB

No, that, I understand. But is it, I mean is it basically coming from asphalt?

Curt Anastasio

Well, a large majority of it is, but we also have a positive margin in the fuels too.

Andrew Gundlach – ASB

You do?

Curt Anastasio

Yeah.

Andrew Gundlach – ASB

And that continues to be the case?

Curt Anastasio

Yeah, I mean, month-to-month, sometimes it's up, sometimes it's down. But for the full year, yeah, it will be a positive contribution from the fuels. But obviously, the asphalt is much more important thing to follow, that's the overwhelming pat of the volume and the profit. So, I guess if you're asking me which of those you should keep your eye on, I would say keep your eye on the asphalt.

Andrew Gundlach – ASB

No, that of course, but I'm just trying to see if there is any contribution at all from the other volumes. I guess what you're saying is, yes, there is?

Curt Anastasio

Yeah, there is, but of course it's small compared to the asphalt.

Andrew Gundlach – ASB

I understand. Okay. Thanks a lot.

Operator

Your next question is from Michael Blum from Wachovia.

Michael Blum – Wachovia

Hi, thank you. Curt, I think you mentioned that, you will be targeting distribution increases later this year?

Curt Anastasio

Yes.

Michael Blum – Wachovia

Do you have a target for annual distribution growth this year at NS?

Curt Anastasio

No, we haven't done that. I mean I know we've done that a couple of times, but what we've said to our Board and we haven't changed that direction from our Board, when everything was collapsing, the financial world and so forth last fall, we said we're going to go into this year cautiously. Let's not set distribution targets. We're going to see how the whole financial, global financial crisis plays out and what, if any, impact it has on us. And of course as the year goes by and we get more and more visibility into how successful we're actually going to be this year, we're going to have an increasing amount of confidence about that distribution increase. And so that's why I can say as much as I've said, is that we are targeting further distribution increases this year, but we have not, covered with our Board exactly what we would want to do on that. They have an idea, of course, but, I mean we really need to get specific guidance from them on that, but it looks good right now.

Michael Blum – Wachovia

Okay. And then just one housekeeping item, the other income line was I think around $8.6 million, what is that coming from?

Unidentified Company Representative

Two, two things really. It's the gain on, in property insurance received in the quarter from Hurricane Ike, which hit Texas City and that's the majority of it. And the second item in there in the quarter is our Canadian subsidiary has a U.S. dollar cash deposit and the FX move on that during the quarter gave them a gain. And then…

Michael Blum – Wachovia

Okay.

Unidentified Company Representative

Last year's first quarter in other income there were three items they was business interruption insurance received from the contingent PI claim that we had when Valero had an explosion their McKee refinery and there was a gain on the sale of the DFW pipeline and I think there was an FX gain the same issue on the U.S. dollar deposit.

Michael Blum – Wachovia

Okay, great. Thank you very much.

Operator

(Operator Instructions). And your next question is from Darren Horowitz from Raymond James.

Darren Horowitz – Raymond James

Curt, when we are looking at the $100 million to $140 million in what asphalt can generate and we are trying to get our arms around where that could fall, could you give us some sense as the demand impulse of what your projected utilization is. I’m just kind of looking for how you think total yields respectively could kind of ramp as we move into the third quarter?

Curt Anastasio

Okay. So, you are asking for utilization rates at the refineries?

Darren Horowitz – Raymond James

At both?

Curt Anastasio

At both of the plants?

Mike Stone

I got it right here.

Curt Anastasio

And it should be around, as we go into the second quarter, it sort of ramped up from, so let's say the 80% level, on up closer to 90% as you get into say by August. That's Paulsboro, but and Savannah is a similar thing, but if you look at the two combined, the total utilization rate you go from something like 72% in April and then by June, we're up to about the high 80s, 88%. And then where we do go two fold whether we go to, where do we go after that?

Unidentified Company Representative

We ramp up and we're in the mid-to-high 80s in the second quarter, 90% in the third quarter, and then ratchet back off to roughly 50% in the fourth quarter.

Curt Anastasio

Which is typical pattern for us I mean that's what you should expect from us more or less normally?

Darren Horowitz – Raymond James

Right, yeah, I was just looking at last year and wondering, if there is anything fundamentally in the market had changed to make those numbers change. Secondly, when you look at all the different types of product that are coming out of those two refineries from a composition standpoint do you see anything that would cause it to change from kind of how you were running last year?

Curt Anastasio

No, I don’t think so should be substantially similar on yield.

Darren Horowitz – Raymond James

Okay. And then just one quick housekeeping question, are you still targeting about 15 million in debt reduction by year-end?

Unidentified Company Representative

It will be higher most likely, now much will depend upon two things. One asphalt and what we actually achieved, which is sort of the one operational wild card because it has to do with margin. And then any potential asset sales or asset purchases. Okay?

Darren Horowitz – Raymond James

Okay. Thank you. I appreciate it.

Curt Anastasio

Okay. Thanks.

Operator

Your next question is from Yves Siegel from Aroya Capital.

Yves Siegel – Aroya Capital

Thanks. Good afternoon.

Curt Anastasio

Hi Yves.

Yves Siegel – Aroya Capital

Guys, it does a little bit of a teaser at the end, Steve, in terms of asset sales or asset acquisitions. What I've really wanted to get a handle on is such terrific returns on the organic growth projects. What are you thinking in terms of when you look at your inventory of organic growth projects of, what's the trigger to decide if you will do one or proceed to do one or not? I mean do you have a sort of a rate of return cut-off it has to be 40%? Could you sort of elaborate on the backlog of projects and what the trigger points are to increase the budget for '09?

Curt Anastasio

First of all, remember the ones we have in that 80 million are in that 40 to 50% IRR range and those are the ones that we've got those are the best ones and those are the ones.

Yves Siegel – Aroya Capital

Right.

Curt Anastasio

To do this year. Beyond that, I don't know if Mike Hoeltzel wants to be comment of just how we evaluate, which projects we end up doing.

Mike Hoeltzel

We rank all our projects and we don't have a fixed hurdle. It depends on the risk associated with the projects. Obviously, we do lower return fee-based fixed income projects as opposed to an asphalt type margin project with the same return, but we've got a lot of projects we're looking at to develop for 2010 and forward once we get through this period of high cost of capital.

Steven Blank

Yeah. And I think, to be more specific on the debt repayment, if we don't have a asset purchase and none were assumed in the budget or additional asset sales, and again none were assumed in the budget, but our current estimate is we probably pay down debt in the range of 125 to 150 this year and we're currently prioritizing capital expenditure projects and taking a look down the list after those higher return ones to see if we should jump start some spending here, hoping, and expecting that the recovery will come. There is plenty of interest for us to build, storage for people and as money frees up, we're getting more optimistic. I mean again, when we put the budget together last year, the capital markets were frozen in October. So, we put together a self-funding budget, which presumed paying down about $25 million to 50 million of debt. And as I said, that's now gone to about $125 million to $150 million really because of a few things, you have lower crude oil cost or working capital load is lighter than assumed in the budget, when we assumed $65 WTI. Interest expense is much lower than in the budget because the Fed has so aggressively lowered short-term rates and we're borrowing under the revolver at about 1% to all in. And then power and other operating costs have come down as kind of evidence of a deflationary period if you will. So, we’re benefiting from all of those things versus the budget.

Curt Anastasio

Yeah. Of course the good thing from where I said is we don’t have to do anything other than what I’ve said we’re going to do, to have a record year and pay down debt and all the things we told you. So, but, we're obviously we're looking beyond 2010 and beyond and we're seeding for the future and we're a growth company. We're going grow, we are going to do acquisitions, we're going to find more projects and, that's what you'll see from us going forward.

Yves Siegel – Aroya Capital

Okay. I have two quick remaining questions, one is how do you prioritize the debt reduction versus, organic growth versus acquisitions? Do you have a target in mind right now?

Steven Blank

Well, the target, if we have a target on debt reduction, it's to get the debt-to-EBITDA down further. It was artificially high at the end of the first quarter at 4.3 because we had that $60 million hedging loss in last year's second quarter, which increased debt by $60 million and reduced EBITDA by $60 million. So, it's a double whammy. We’ve talked to the rating agencies about getting that below 4, which is where we think it should be. It was actually a 3.99 at the end of December. It grew during this quarter really for two reasons. One, we're building inventory, so we incur a little bit more debt to get ready for the asphalt season, but most importantly, we lose a strong quarter, it's a trailing test and what would have been a strong quarter for us in the second, because of the hedging loss, became a weak quarter for us. So, it's an unusually high number. We think the number will be closer to three to one by the end of the year, and that's very strong. And we'll have one of the strongest debt to EBITAs in the LP space I would imagine. So, that's all good. So, as we continue to delever and we have ample liquidity under the revolver, we have currently about 470 million under the revolver available to us. Our debt has built by a about 100 million this month, again, associated with building asphalt inventories, getting ready for this season. So, I think we're in great shape and money is available if we wanted to go into the capital markets, but we don't think we need to, I mean we're borrowing at 1% under the revolver, 10-year cost of money might be 10% for us. So, we only want to do a capital market deal if we really have to, which would assume an M&A deal.

Yves Siegel – Aroya Capital

Okay. Thanks for the clarification there. But the last question is on moving throughput revenues to storage lease revenues, is there an opportunity to continue to have that migrate or do you think you are pretty much done where you are right now?

Mike Hoeltzel

We moved pretty much I think everything we can. We really, all we have left is really some refinery tanks at a few core refineries I don’t think they are going to have any interest in converting those to a lease payment, they are going to want to lease those throughput base, but pretty much everything else, which was about 55,000 barrels a day of throughput contracts we had converted to lease at much higher margins to I might add.

Yves Siegel – Aroya Capital

Great. Thank you, very, very much.

Operator

And at this time there are no further questions in queue.

Mark Meador

Thank you, operator. If any have any further questions please feel free to call us at NuStar. Thank you for joining us today.

Operator

Ladies and gentlemen that concludes today’s conference call and you may now disconnect. Thank you.

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Source: NuStar Energy LP Q1 2009 Earnings Call Transcript
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